Increasing taxes after a financial crisis : not a bad idea after all...

  • Based on OECD evidence, equity/housing-price busts and credit crunches are followed by substantial increases in public consumption. These increases in unproductive public spending lead to increases in distortionary marginal taxes, a policy in sharp contrast with presumably optimal Keynesian fiscal stimulus after a crisis. Here we claim that this seemingly adverse policy selection is optimal under rational learning about the frequency of rare capital-value busts. Bayesian updating after a bust implies massive belief jumps toward pessimism, with investors and policymakers believing that busts will be arriving more frequently in the future. Lowering taxes would be as if trying to kick a sick horse in order to stand up and run, since pessimistic markets would be unwilling to invest enough under any temporarily generous tax regime.

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Author:Christos Koulovatianos, Dimitris Mavridis
Parent Title (English):Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 614
Series (Serial Number):CFS working paper series (614)
Publisher:Center for Financial Studies
Place of publication:Frankfurt, M.
Document Type:Working Paper
Year of Completion:2018
Year of first Publication:2018
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2018/11/29
Tag:Bayesian learning; Gamma distribution; controlled diffusions and jump processes; learning about jumps; rational learning
Issue:October 28, 2018
Page Number:43
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
JEL-Classification:C Mathematical and Quantitative Methods / C1 Econometric and Statistical Methods: General / C11 Bayesian Analysis
Licence (German):License LogoDeutsches Urheberrecht